A Tale of Two Budgets

This is a tale of two Budgets. The first is the one you heard about from George Osborne in the House of Commons today; the second is the one going on underneath the surface – the one he didn’t want you to see.

The first Budget – the one Mr Osborne actually talked about – was eye-catching without being particularly life-changing. There was a tax on fizzy drinks, some avoidance measures, a new lifetime ISA which might well be the beginning of the end of the current pensions system, an increase in the tax-free personal allowance, a cut in corporation tax and capital gains tax, a freeze in fuel duty and some changes to the schools system which really shouldn’t have featured in a Budget at all.

The important thing to note is that interesting as some of those measures might be (for instance, overhauling the tax treatment of corporate debt for the first time in a century and a half!) they don’t make much of a fiscal difference.

The fizzy drinks tax generates £500m a year when it kicks in in a few years’ time, the avoidance measures make a few billion (as they normally do), the lifetime ISA costs a few hundred million pounds a year, as do the education changes, the corporation tax cut and the fuel duty freeze. The increase in the tax allowance costs £2bn, which is not insignificant, but nor is it earth shattering.

So much for the Budget the Chancellor wanted to talk about, what about the one he dearly didn’t? Let’s start with the three fiscal rules he set himself last year: the surplus rule which stipulates he needs to have wiped out the annual deficit on government spending entirely by 2019/20, the rule which says the national debt needs to fall every single year and the welfare cap which limits spending on benefits.

Mr Osborne already broke the welfare cap last November when he cancelled his planned tax credit cuts. Today he also broke the national debt rule, since debt is higher this year, as a percentage of UK gross domestic product, than last year (up from 83.3% of GDP last year to 83.7% this fiscal year).

Why? It largely comes down to the fact that the economy is a lot weaker than previously thought. In November the Office for Budget Responsibility thought the UK would grow by 2.4% this year. It now thinks growth will be weaker, at just 2%. Worse, it now thinks the long-term growth potential of the UK is also considerably lower. Trend growth, as economists call it, used to be about 2.75%. After the crisis that dropped to around 2.4%. Now the OBR thinks it could be as low as 2.1%.

Weaker growth means weaker tax revenue, which in turn means higher debt and higher borrowing. That’s why the Chancellor not only broke his debt rule, but why borrowing is so much higher in future years than previously expected. For instance, the Autumn Statement predicted that by 2018/19 the Chancellor would have whittled down annual borrowing to a mere £4.6bn. Today that borrowing figure was notched up a whopping £17bn to £21.4bn.

Given all of that you might have assumed the Chancellor would miss his other fiscal rule – to get an overall surplus in the public finances by 2019/20. Indeed, had he done nothing today, he wouldn’t have achieved that surplus at any point in the next five years. But against all the odds, he has managed to meet this target, once again generating a £10bn surplus in 2019/20.

How? The short answer is a lot of jiggery-pokery beneath the surface. Essentially, every bit of spending that could be moved forward has been shifted into the next couple of years. Every bit of tax revenue that could be shifted into 2019/20 has been shifted backwards. So an apparently arcane corporation tax change to bring forward payments now miraculously kicks in in 2019/20. A slug of spending on railways and investment (you remember that stuff about Crossrail 2 and HS3 yesterday?) has been brought forward. Most of all, we have yet more austerity suddenly kicking in in 2019/20: both that heavily-trailed £3.5bn cut and a further £2bn slice taken off public sector pensions.

The upshot of all of that is a sudden enormous improvement in the public finances in 2019/20. Some of the shift is sustainable, because it represents real spending cuts; some of it is just a mirage, since it’s tax revenue shifted from one year to another. But, by hook or by crook (and he has employed both) the Chancellor has managed to avoid breaking his fiscal rule.

Whether all the effort was worth it is an open question. Most economists question how wise it is to aim for a surplus at all. But it is increasingly clear that Mr Osborne wants his legacy to be securing the first surplus in Britain’s public finances for decades – whatever it takes.